Alan Grayson’s e-mail on Moody’s warning that it might reduce the US’s AAA rating, suggested that Moody’s was either threatening a downgrade because it wants to get the Bush tax cuts for the rich extended, or, alternatively, that “Moody’s is living in what Aristophanes called “Cloud Cuckoo Land.”” He says this because Moody’s is upset about the possibility that the US may go over the so-called “fiscal cliff,” even though if it did, it would theoretically result in $560 Billion of deficit reduction annually, without further legislative changes, and it makes no sense on the surface for a ratings agency to think that the risk of US bond default is greater when the annual deficit is being reduced by $560 B per year, than by some lesser amount, which is likely to happen if Congress doesn’t take us over that “cliff.”
Grayson was right to call attention to this seeming contradiction and the possibility that Moody’s is just pressuring Congress to do more for rich people; but I think he should also have made the larger and more important point, that Moody’s warning, just like the one it delivered in January of 2010, is an empty threat without significant consequence, even if it were carried out. How do we know that? For a number of reasons.
First, as is widely known, all the ratings agencies including Moody’s gave the CDOs and CDSs that led to the collapse of AIG their highest AAA ratings. In addition, they downgraded Japan’s credit ratings a long time ago, with no measurable impact on its bond interest rates or costs, even though Japan’s debt-to-GDP ratio has continued to increase over time and is now in the neighborhood of 200%. More recently, in April of 2011, Standard & Poor’s downgraded the outlook on US debt from stable to negative. What happened thereafter? There was a flight to Treasuries on the International markets and interest rates have fallen more than 1% since S & P delivered its downgrade.
So, one may be forgiven for wondering why anyone should listen to the ratings ravings of Moody’s and the other agencies at all. In fact, one may begin to suspect that their ratings have little influence on the bond markets, and also, given the Japanese and US experiences, one might even suspect that the bond markets don’t influence to any appreciable degree or control the interest rates that Governments sovereign in their own currency must pay.
Second, since the United States is a nation with a fiat non-convertible currency system, with a floating exchange rate, and no debt denominated in any foreign currency, it is impossible for the United States to be forced into a default by any external party, simply because its ability to create the currency it owes its obligations in, is unlimited. Voluntary default could be caused by a Congress which acts stupidly, and in a manner contrary to the 14th Amendment of the Constitution, to constrain the Treasury from paying its obligations when they come due, coupled with a Treasury that accepts Congress’s constraint in conflict with the clear admonition of the Constitution that the debts of the United State shall not be questioned.
The objective risk of default by the US Government is not increased by the increased size of the deficit, debt, or debt-to-GDP ratio. And Moody’s apparent view that the risk of default is increased by such increases, only shows that Moody’s doesn’t understand the monetary operations of nations sovereign in their own currencies. Increases in these numbers don’t in any way lessen the constitutional authority of the Government (including the Congress) to spend or make money.
It’s basic solvency, in other words, is untouched by any deficit reduction deal that may or may not be made by Congress. And, if the Executive uses its own legal currency creation powers, then the economic/fiscal risk of default, as a result of any deficit reduction deal made or not made, is exactly zero. Whatever additional risk exists from a failure to avoid the fiscal cliff, or a negotiated deal that provides for deficit reduction, or doesn’t provide for it, is purely political.
It comes only from the possibility that Congress, mistakenly thinking that the Government is like a household, or, for ideological reasons, determined to “starve the beast”, might try to constrain the Executive from meeting its obligations, and declare a US default when there is no reason to do so. Even here though, there is actually very little political risk because so many options exist for the Executive to get around any panic that may afflict the Congress.
Third, Moody’s warning assumes that its ratings and the bond market itself can actually influence, or even control, the interest rates that Governments like the United States must pay. But the problem is that they don’t!
The Federal Reserve, and sometimes the Fed and the Treasury in collaboration, target bond interest rates and set these for the bond markets by manipulating bank reserves. Specifically, one way to do this, is that the Fed can buy long-term debt removing much of it from the market, and the Treasury can cease issuing any more long-term bonds, and can sell only three-month bonds when it issues debt.
Three-month bond interest rates are generally controlled by overnight rates for bank reserves, and overnight rates can be driven down to near zero by flooding the banks with excess reserves. That’s basically how the Japanese keep their bond interest rates near zero, and that’s how we’ve been doing the same for some time now. In fact, the Fed announcement just yesterday included plans to buy more long-time securities.
Another move the US can make to remove the effects of the bond markets and the ratings agencies upon public finances, is for Congress to stop requiring new debt issuance in coordination with deficit spending, and for the Treasury to stop issuing debt. In other words, allow Treasury to credit its Fed account to repay debt and spend appropriations already approved by Congress at will.
Alternatively, the Executive Branch could use its legal power to mint proof platinum coins with Trillion dollar face values, and then deposit those coins at the Fed to cause it to issue electronic credits in the Treasury General Account (TGA) in amounts great enough to remove the need to issue debt instruments in coordination with deficit spending. If we did either of the above things, then the credit rating agencies’ impact on the bond market for US sovereign debt would be irrelevant from that day forward.
In short, the bond markets and the ratings agencies aren’t in control of US public finances. They are not in a position to influence what our taxing or spending policies ought to be, or whether we will default on our obligations, unless we allow them influence.
So forget about Moody’s and its idle threats! They’re part of the great austerity distraction preventing us from focusing on our real problems. There’s nothing that Moody’s and the bond vigilantes can do to hurt us, unless we let them. Let’s not let them. Tell them to bring those ratings changes on! Tell them to go ahead and destroy their own credibility, the way S & P did last year!
In fact, let’s give them what they deserve for their role in the crash of 2008, and their continuing arrogance and fraudulent ratings behavior designed control various democracies, including our own, since. As Bill Mitchell says in his post on outlawing the credit rating agencies:
“The real question that I always ask is why governments allow these undemocratic criminal organisations to exist. They can just outlaw them. This would force the corporate players to create better ways of informing the markets about their risk characteristics and leave governments alone to do what they are democratically elected to do – advance public purpose.
Further. as part of my preferred financial market reforms I would render illegal a whole swag of derivative assets which would lessen the problem of pricing risk.
It is time to wean the private financial markets off these agencies. The best way would be to declare them illegal.. . . . “
— Mike Norman provides the same conclusion in this timely video!!!
Also: Mark Weisbrot in The Guardian,
Moody’s threat to downgrade US debt is political, not fiscal
There is no risk of default on US bonds. Moody’s warning about its AAA rating serves a rightwing agenda of public spending cuts
Thanks, Steve. Absolutely right!
I read somewhere that a second downgrade would trigger compulsory selloffs of T Bonds by pension funds and other institutional investors. Not true? Not a big deal?
It’s nonsense. As long as the Eurozone, Japan, China, India, and the Middle Eastern nations want to export to the United States, there will be a market for debt issues by the Treasury. And if there weren’t, then the Fed could buy existing debt, making it scarce, which would also drive up demand for it. As long there is a market, and there’s no trouble selling the debt, the pension funds will have to hold it. After all, they, especially, need safe investments, and whatever Moody’s, Fitch, and S & P say, US debt will still be the most risk-free investment in the world!
Think it’s about clauses for some investment funds which insist on AAA investments. Talked about this with Beowulf a while back at Mosler’s site. Thinks the 14th amendment would apply, and that the State AGs would write letters saying they were not legally binding.
That’s interesting. But the best solution is the one putting the ratings agencies out of business for fraudulent behavior. Then the clause would be inapplicable, and no one would have trouble with them in the future. If we need ratings, let the Consumer Financial Protection Bureau do it!
Agreed. If they have as much power as they think they have – and do – they are too big to exist, just like a TBTF bank. Even if they hadn’t enabled and engaged in fraud, and taken bribes, they’re Systematically Dangerous Institutions performing a quasi-public function too. At the loosest, they should be as regulated as banks are, and under any reasonable regime, they would have had their management replaced and convicted longa ago.
Excellent analysis, Joe. I’ve referenced it on my blog.
Rodger Malcolm Mitchell
Thanks Rodger. I appreciate it!